Health Professionals Will Respond to Incentives, If We Only Let Them

By Tom Scully

Local exchanges and markets will be better for health care costs than Washington price-fixing.

Jim Bourg/Reuters

It is nobody's fault, but our health finance
system has long been a disaster. Since World War II it has slowly evolved, with all
the best intentions, into not one but at least three wholly separate entities--each with different infrastructures and different sets of perverse incentives
for hospitals, doctors, and other providers. This nutty system of finance is the reason that health care expenses are
swallowing the U.S.
economy (and federal and state budgets), and that health care is our biggest
domestic policy issue. The health care profession has always been quite
honorable, but the reality is that these professionals--physicians, nurses,
hospital administrators alike--aren't immune to financial incentives, and the
incentives created by our current system are completely out of whack.

1) Medicare: The almost 50 million Medicare beneficiaries
(seniors and the disabled) make up about 16 percent of the U.S. population--but account for over 40
percent of the spending for the average health-care system, public or private. Medicare drives
everything in local health economics, because seniors consume lots of health
care and they are in the hospital often. For three-quarters of Medicare beneficiaries, traditional Medicare programs fix prices nationally.
Think about that--every hospital and every doctor gets paid the same thing!
Recently there have been minor variations through "Accountable Care
Organizations" and other "pay-for-performance" models--but for the vast bulk of services,
the worst hospital in town gets paid the same as the best.

Not surprisingly, this crazy pricing scheme
incentivizes volume. Physicians try to see more patients; therapists try to do
more therapy; hospitals try to book more surgeries. It is predictable human
nature, and has been in every society in history. Health care is the only
service in the U.S.
where the government fixes prices--is it a surprise that volume has exploded?

2) Medicaid: Medicaid is the program for
low-income Americans, including the disabled and the elderly (usually in long
term care). Actually, Medicaid is not one program, it's 50 totally different
state programs. Seventy-seven million Americans were on Medicaid at some point in
2011--almost 25 percent of the population, at a cost of $440 billion. And we
plan to begin adding 18 million more Americans on January 1, 2014, for another
$120 billion a year, under the Affordable Care Act.

Talk about a mess! Every state provides
different coverage, and Medicaid is a chaotic hodgepodge of policy. Even worse,
virtually all the states have succeeded in transferring much of the cost to the
federal government over the past 25 years through "provider taxes,"
"intergovernmental transfers," and "upper payment limits," so that no state
actually pays anything remotely close to its statutory "match rate." The entire
program is a giant state refinancing scam. What initially was a 50-50 federal
program, is now more than 70 percent federally financed, with some states, most notably New Hampshire, not contributing a single nickel of state general revenue. This lack of program integrity is a problem, because it makes
the program unreformable. There is no policy equity among the states, so any
reform proposal will create some winners and some losers, unless you spend even
more money. So it will never happen.

States have increasingly moved to Medicaid
managed care, but the bulk of daily health services are still paid in the old
"fee-for-service" methodology. And guess what: those states also fix prices and
pay all providers the same amount, almost always using the Medicare system as
the reference payment. If you are a hospital or a health system,
you already have 40 percent of your payment coming from Medicare, and in
addition you probably have another 12-15 percent of your revenue coming from
Medicaid. So 50-55 percent of your payments come from two giant price-fixed
national programs--and you get paid the same rates, no matter the
performance. How's that for an incentive structure?

3) Commercial Insurers/Blue Cross/Employer
Plans: Private insurance generally makes up another 35-40 percent of the health
care spending total (the uninsured fill in the remainder). There are a few
markets with dominant Blue Cross plans that actually have leverage. But in most
markets there are a handful of insurers: rarely does any one player have more
than 20 percent of the market, and often it is far less. So why would a
hospital care intensely about improving performance, or cutting prices to meet the demands of Aetna, Cigna, or United, when those companies rarely wield
significant market share and are bit players compared to Medicare and
Medicaid? In fact, most commonly, insurers still pay a percentage of--you
guessed it--the Medicare fee schedule. Ask a doctor or hospital what an insurer
pays them, and you will likely get "105 percent of DRGs" (the Medicare hospital
fee) or "103 percent of RVUs" (the Medicare doctor schedule).

The reality is that Medicare is the reference
price--and you have what amounts to de
facto federal price setting for virtually all health services. Medicare is
so big that its payment is the model for everyone else--including Medicaid and
commercial insurers. The sad truth is that Medicare fixes the unit price for
most services--so there is very little reason for anyone to compete on price or quality.

Long story short: our system of finance is
irrational and disorganized and presents perverse incentives to doctors,
hospitals, and communities.

Is there a better model?

Surely no one starting again would design the
one we have. The best option out there is probably the Federal Employees Health
Benefits system, which all Congressmen from both parties claim to love.

The best effort to track that system, and
probably the most competitive health reform plan, comes
from Senator Ron Wyden of Oregon.
His Healthy Americans Act is the correct approach. The bill eliminates Medicare
and Medicaid as we know it--and with it federal price fixing. It creates local
exchanges and markets offering a variety of well-regulated private plans to
all, regardless of age or income. Low-income Americans (that is, at the Medicaid level) would
have their plans heavily subsidized. Seniors would also retain Medicare-level
subsidies. But there would be one market for health plans, and one set of
health financing incentives. Competition among private health plans would drive
behavior and costs, as it does in the rest of our economy.

Health professionals will follow the right
incentives if we allow them to. They will produce quality outcomes,
equitably, just as we have done in other sectors of our economy. The government
has a role to play--but it is not by fixing prices.